Sunday, July 12th, 2009

“Cleveland’s leadership has no apparent theory of change. Overwhelmingly, the strategy is now driven by individual projects. These projects, pushed by the real estate interests that dominate the board of the Greater Cleveland Partnership, confuse real estate development with economic development. This leads to the ‘Big Thing Theory’ of economic development: Prosperity results from building one more big thing.“

The answer possibly lies in structural economic changes resulting from the nationalization and globalization of industry. Up until the 1990’s, many businesses, such as retailing, utilities, some manufacturing, and especially banking operated on a regional or local basis. The meant that the civic leadership of a community was heavily dominated by businessmen, again, especially bankers, whose success was dependent on the overall macroeconomic health of the particular city or region they were located in.

But with banking deregulation, we saw large numbers of hometown banks merged out of existence. Industry after industry was subjected to national or international level roll-ups as changes in the economy and regulatory environment gave increasing returns to scale.

Why is it that “real estate interests” dominate in a local economy like Cleveland? Because, to a great extent, they are among the only ones left. Consider the local industries that were not as subject to roll-ups. Principal among these are real estate development, construction, and law. This means the local leadership of a community is now made up of executives in those industries, and they bring a very different world view versus the previous generation.

Consider the difference between a banker and a lawyer. Banks make money on the spread between what they pay for deposits or wholesale funding, and what they charge for loans. This means the CEO of a bank is making money while he plays golf at 3. He’s got a cash register back at the office that never stops ringing.

By contrast, lawyers get paid by the hour for work on specific matters and transactions. The law partner is only making money on the golf course if he is closing a deal. It’s similar between many other “operational” businesses that were previously prominent in communities, and the “transactional” businesses that are now often dominant.

Additionally, even where the hometown bank or company did not get bought out, it likely escaped that fate by getting big itself and making large numbers of acquisitions or otherwise expanding. This means those institutions are less dependent on the health of the particular local market they happen to be headquartered in than they are overall macroeconomic conditions. While no doubt they want the headquarters town to be successful, not least of which so they can effectively recruit talent, they can afford to take a portfolio view of local markets.

Not only has the drying up of local and regional operating businesses led to a business leadership community unbalanced in favor of transactionally oriented firms, the loss of those local and regional operating businesses robbed many of the transactional companies such as law and architecture firms of their principal local client base. Large national businesses employ national firms for advertising, law, architecture, etc. If they use local firms, it is in a subsidiary role. (Or, if a smaller firm is fortunate enough to land a contract, it is servicing a client on a national, not local basis).

Richard Florida described this in his Atlantic Monthly article on the financial crash. “As the manufacturing industry has shrunk, the local high-end services—finance, law, consulting—that it once supported have diminished as well, absorbed by bigger regional hubs and globally connected cities. In Chicago, for instance, the country’s 50 biggest law firms grew by 2,130 lawyers from 1984 to 2006, according to William Henderson and Arthur Alderson of Indiana University. Throughout the rest of the Midwest, these firms added a total of just 169 attorneys. Jones Day, founded in 1893 and today one of the country’s largest law firms, no longer considers its Cleveland office ‘headquarters’—that’s in Washington, D.C.—but rather its ‘founding office.'”

Where then is the source of transactions these firms can turn to in order to sustain their business? The public sector, of course.

I would hypothesize that many local transactionally oriented services companies have seen the public sector take on a greater share of billings than in the past. With the old school bankers and industrialists mostly out of the picture, the leadership in our communities consists increasingly of the political class and a business community dominated by transactional interests.

When you look at the composition of this group, it should come as no surprise that the publicly subsidized real estate development is the preferred civic strategy. Politicians get to cut ribbons. Cranes always look good on the skyline. Local architects, engineers, developers, and construction companies love it. And there is plenty of legal work to go around.

This is not to say these people are acting nefariously. And nor were old school bankers and industrialists always acting purely altruistically. Rather, the difference comes from the world view and “theory of change” that people steeped in transactionally oriented businesses bring with them.

With the current financial crisis, bigness, as a strategy, is out of favor for the moment. Also, the gimmicky financial transactions that underlie much of the crisis are calling the entire transactional model into question. There’s an increasing alarm at the precipitous decline of manufacturing, particularly the auto sector. And people are questioning whether we as a country can survive simply through services, or whether we need to revitalize the concept of the operational business and actually making things. Plus, real estate deals are tougher to get done because of tight credit, and it seems unlikely that the go-go days of recent years are coming back soon.

We’ll see where this leads. But if we see more local and regional scale operating businesses start to emerge again, then perhaps the urban development pendulum will start swinging the other direction again. In the meantime, large scale real estate development will likely continue to be preferred.

18 Responses to “Globalization and Civic Leadership Culture”

Well, any redevelopment initiative that involves land use is, in effect, a "real estate deal," including those that involve public properties such as roadways and public spaces. Citygarden in St. Louis is a real estate deal. Millennium Park is, especially, a real estate deal.

The public sector turns to development community because they, in theory, have a better understanding of marketplace dynamics… supposedly, they have access to market research that validates their investment risk. Market research undertaken for public planning projects are largely recitations of census data, with no value added. In others words, useless. So, public officials turn to the private sector for economic development expertise, albeit with a great deal suspicion when subsidies are requested.

In this day and age, governments have unprecedented abilities to use public investment for projects that produce "four dimensional sustainability." That is, projects that are not only environmentally sustainable, but socially, culturally and economically as well. That's what Millennium Park, Citygarden and Rich Daley's premium streetscapes are all about.

Clearly, projects involving real estate redevelopment have been part and parcel of civic success for many years. I agree that building quality civic spaces is important.

But this is not the end all be all of civic success. I've cited a few examples (linked on my best of) of good economic development strategies. Things like the Motorsports target cluster in Indy, as well as a couple of other things there I plan to highlight soon show economic development that transcends mere buildings.

Also, look at the example of the Indy amateur sports initiative, which did have a large facilities component to it, but in which the buildings were subsidiary to a larger change strategy.

I understand what your saying. I agree wholeheartedly that any investment—public or private—that's disconnected from a comprehensive strategy is not really strategic.

Most public officials and residents don't understand how their cities function as products in a marketplace. It's not the only way to look at places, but without a "product development strategy," resources are dissipated without maximum impact.

To me, it's all about investor confidence—the strategies that attract and retain private sector investors, including local home owners, merchants and commercial property owners who choose to stay put and take a risk on the future prospects of their own communities.

"… leadership has no apparent theory of change. Overwhelmingly, the strategy is now driven by individual projects. These projects, pushed by the real estate interests… confuse real estate development with economic development. This leads to the 'Big Thing Theory' of economic development: Prosperity results from building one more big thing."- Ed Morrison, Cleveland: Reconstructing the Comeback via The Urbanophile"

For some "proof" of The Urbanophile's hypothesis, look at the affiliations of board members of any significant not-for-profit in a Midwest metropolitan area and compare it to a similar list from the 1980s or early 90s. I'm thinking of museums, the symphony, United Way and its biggest agencies, public TV station, etc.

Pretty much the only thing still the same is the scions of old-money families and the local bank "market presidents" (who now report to a regional president in some other city and not a local board of directors).

I would add to Aaron's list of "transaction-driven" industries environmental firms, consulting firms, PR and ad agencies and accounting firms…basically anyone who sells time by the hour or project. Pretty much the whole "creative class".

Would it be fair to venture that in this setting, "transactions" = "buzz"? Would the creative class flee a city without "buzz" (sufficient transactions)? Is this why it's important to hold onto the creative class?

Thirty years ago, Cleveland was second only to New York City as a headquarters city for Fortune 500 companies. In general,the leaders of these companies were residents of the community, and had grown through the management ranks in Cleveland, together with their management and leadership peers. The corporate community was a real community; peers knew peers, and leadership was personal.

The civic landscape is far different today. Headquarters companies have moved, merged or evaporated to a very few. As your excellent article pointed out, the banking leadership has undergone profound change, and even the law firms which had been powerful for more than a century are managed locally by local "account executives" who are measured by their peers not by the amount of civic leadership they provide, but by how much revenue they generate for their partners. Their leadership positions provide a means to that end.

For five decades, economic development in Cleveland was the purview of the local utility monopolies, who made major investments in economic development marketing and contributed in large measure to green field suburbanization. Now, those companies are largely gone as well.

Today, the community's largest employers outside of government are two non-profit health systems, whose two major emphases are on service delivery and real estate management. Even they are setting their sights outside the region for lucrative new opportunities; there's a limit to the future of providing medical services for a population in precipitous decline.

So, where 30 years ago the Chamber's Board consisted largely of home-grown CEO's and managing partners of headquarters companies, the Board today consists of lower-level regional or local "colonial governors," who are either on their way up or on the way down their own corporate ladders; nonprofit CEO's, whose positions largely depend on corporate institutional support, a few "token" entrepreneurs, be they women, minorities, or other heads of successful small businesses who are happy to be counted among the "corporate elite"…and the developers.

For the better part of twenty years, therefore, the Chamber's principal mission has been to lobby for public funding to promote both public and private development projects.

Today, the Chamber has "outsourced" most traditional development activity to a much weaker "regional" partner, in order to focus on lobbying for convention centers, casinos, and other projects whose economic value have been largely debunked by the experience of other communities, but provide deeply-entrenched developers, plus the lawyers and investment bankers who enable them, with the revenues which flow from big public subsidies.

For developers, the Chamber staff represents an excellent investment in their own self-interests. And in an environment in which other members of the Chamber's Board are either focused on their own companies or afraid to provide any independent critical thinking because it might alienate a big supporter, there are few organizational checks and balances, and the staff and developers run amok.

It's a pernicious downward spiral, as anyone who might challenge the status quo is either ignored and frustrated or asked to leave the Chamber's leadership. So smart people leave the leadership, the weak and self-serving stay, and the staff perpetuates itself in an organization whose leadership, because of the temporary nature of many of its members' stay in town, turns over almost 100% every three years…except for a few deeply-entrenched, self-dealing insiders.

I'm not sure the operational/transactional distinction holds outside FIRE and related industries like law and government. In software or scientific research, you're paid only for the hours you work, too. A professor who runs a lab only gets paid if he or his students conduct research that brings results; a programmer only gets paid for the hours he spends writing software. And yet, neither sector is anything like law. They're not ancillary to anything, so it's not surprising that they've powered Boston and the Bay Area, while legal services haven't powered any region.

To use some similar but distinct language, I think these phenomenon is linked to the idea that the economy has increasingly moved to a focus on "transactions" rather than "relationships." The smaller, local firms/professionals you talk about earned their keep by managing relationships, long-term series of transactions with their clients. Increasingly our legal, banking, etc. interactions are just single transactions, analytically managed by large organizations that don't take into consideration the possibility of future relationships with the client. This has led to a distinction between economic transactions and community interaction. These used to intermingle, so that we all had to work with each other with the expectation that we would interact in the future, in both economic and non-economic ways. Now a relationship is solely economic, often with someone from a different geographic location, and their is no flexibility outside of the brute economic relationship.

URBANO (or ECON GURUS): Do you think local/regional businesses and groups doing business with other local/regional companies would improve local economies dramatically? For example architectural firms were mentionied. Do midwest cities stand to benefit from hiring local/regional firms for both public and private projects – thus keeping cash local? Would keeping that money local, "trickle" into the local economy, and actually lead to increased prosperity?

I previously would have answered "of course" to all above, but have had conversations with colleagues and friends recently who have argued against that. They claim doing business on a national level with larger companies, results in more prosperity via investment results (basically from owning stock.)

I am not sure there is an absolute right or wrong here, but other thoughts on this would be nice. I think this question is within scope.

JG, I think what you're asking is, "Is inter-regional free trade a good thing for the Midwest?". In that case, my understanding of new trade theory is that a free trade bloc is the most beneficial to the part that's the most average. In more developed areas, this means the poorest section, which offers the most cheap labor; in less developed areas, this means the richest section, which offers the most skilled labor.

I don't know what this means for the Midwest, though. Nationwide the growth in trade and mobility is the most helpful for the less developed South and least helpful for the more developed North. But the Midwest has nothing like the North-South disparity. It has plenty of deindustrialized cities, but deindustrialized doesn't equal undeveloped, and those cities don't really have cheap labor. (Indy, Columbus, and Kansas City kind of do, and are indeed the most Sunbelt-like cities in the Midwest).

Thanks for the comments. Interesting to hear your view of specific organizations, Sputtering.

anon 11:33, the main reason I never reviewed LOS was the lack of photos. I missed out on the community days tours, and my lousy old point and shoot camera can't easily do justice to the facility. I think it is a mixed bag. Tough to do justice without a mammoth series, however.

Alon, I'm not sure I agree with your examples. There are a number of classic professional services firms in the IT field, but the bulk of IT folks work in corporate staff positions or other similar organizations. The technology firms that dominate Silicon Valley and Boston are not the "pay by the hour" type firms, but rather product companies of various types. This makes them much closer to the operational businesses I mentioned earlier.

The communities of any real size powered by university research seem by and large to be those that also commercialize it.

anon 1:47, that's a great observation. I've read many an article with law partners bemoaning that they are no longer trusted business advisors to their clients, but rather competitors for commodity transactions to be awarded based on cost. There's probably good that comes from that focus on cost-efficiency, but I'm sure there's a price to be paid as well.

You're right that neither academic nor software jobs pay by the hour. However, I'm still not sure that this is the true difference between finance/software/science and law. Whether people get paid by the hour or not depends on the industry's internal culture. Law, teaching, manufacturing, and retail pay by the hour; FIRE, science, software, and health care don't.

Aaron's chief example is RE development and RE sales, both of which are transactional in nature. Ditto for insurance and finance; personal liability insurance is all about price nowadays (quoth the gecko).

And with a high-deductible insurance policy, you can bet I'll shop around for the price of a procedure…further commoditizing it. And in my last employer-paid HMO, if my doctor dropped out, I had to get a new doctor to remain covered.

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